Firing on all cylinders, the Reserve Bank of India (RBI) on Tuesday came out with yet another set of measures to squeeze liquidity in a move to halt the Indian rupee's free fall against the US dollar. Just a week ahead of its first quarter monetary policy review, the central bank tweaked some borrowing measures by banks, which is likely to make money costlier by raising demand for the rupee.
Those moves in turn, should resist further decline of the Indian rupee against the US dollar curbing the exchange rate volatility. All such liquidity tightening measures are seen as an alternative way to hike interest rates. Higher rates are expected attract overseas funds.
Since May 2, the local currency dropped more than 11 percent till the close of July 19 at Rs 59.80/USD. On Tuesday, the rupee closed at 59.76 against the greenback compared with 59.72 on Monday.
The apex bank restricted the limit of individual bank borrowing to 0.50 percent of its total deposits (or net demand and time liability as it is known in banking parlance) outstanding as on the last Friday of the second preceding fortnight from the RBI's daily borrowing window called Liquidity Adjustment Facility (LAF) in banking parlance.
At the same time it scrapped its earlier measure that had limited the total LAF borrowings to the tune of 1 percent of total deposits or Rs 75,000 crore. It was effective from July 17, 2013.
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What is LAF?
LAF is the combination of two auction routes: repo and reverse repo. While banks borrow from repo currently at 7.25 percent, they park their excess liquidity via reverse repo rate at 6.25 percent.
The role of Marginal Standing Facility
Last week, RBI had raised the interest rate of Marginal Standing Facility (MSF) by 100 bps to 10.25 percent as against 9.25 percent previously. Banks can borrow money pledging their excess SLR (Statutory Liquidity Ratio in excess of mandated 23 percent) bonds in the MSF auction window. Interestingly, not a single bank bid for the MSF auction conducted on Tuesday.
Cash reserve ratio (CRR) or the portion of deposits banks keep with the RBI, stands at 4 percent. Banks generally maintain a minimum 70 percent of total CRR obligation on an average daily basis during a fortnight. However, it needs to be adjusted by the end of a fortnight to maintain 100 percent. In a fresh move, RBI increased the daily average requirement from 70 percent to 99 percent.
"Effective from the first day of the next reporting fortnight i.e., from July 27, 2013, banks will be required to maintain a minimum daily CRR balance of 99 per cent of the requirement," RBI said in a notification.
Impact of measures
While short-term interest rates are likely to increase, the foreign exchange market should get a positive sentiment. Banks are expected to rush to MSF window to raise overnight money at 10.25 percent.
"Prima facie, there will be re-rating of short-term rates," Ananth Narayan, Co-Head of Wholesale Banking, South Asia, Standard Chartered Bank told moneycontrol.com.
"The overnight interest rates including in treasury bills, certificate of deposits, commercial papers and short-term (within one month maturity) deposit rates will rise immediately. Shorter term bond yields would rise while the impact will be less for longer term bond yields. At least, the RBI is demonstrating true intent sending strong message to the markets. The rupee should rise on the back of a positive sentiment, at least for the time being," he said.
According to N S Venkatesh, head - treasury at IDBI Bank, post the measures the exchange rate volatility could reduce with some signs of stability.
"After the earlier liquidity measures (last week), the rupee has stabilized and the volatility has reduced to a one month low. The latest measure should help sustain the rupee-dollar exchange rate in the short range of 59-59.50 levels. the stability of the rupee will be maintained," he said.
Based on a review of the measures, and an assessment of the liquidity and overall market conditions going forward, it has been decided to modify the liquidity tightening measures, RBI said.